THE FIVE GIANTS - discouragement
The UK tax and benefits system is huge and growing. The government raised over £1.1tn (36% of GDP) in tax revenue in the financial year 2025–26 and is forecast to grow to 38.6% of GDP by 2031–32. A high tax burden will have effects on behaviour – of both workers and business - but it is important that policymakers minimise these disincentives.
The UK tax system, in its current form, is poorly designed in multiple dimensions and creates many damaging disincentives and distortions.
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Author
Rahat Siddique
introduction
The UK tax and benefits system is huge and growing. The government raised over £1.1tn (36% of GDP) in tax revenue in the financial year 2025–26. That is forecast to grow to 38.6% of GDP by 2031–32. That will be the highest tax burden since the second world war, and will also mean that the 2020s will have seen the biggest sustained increase in the tax burden in peacetime.
The design of taxes always matters because of their effects on businesses and households. When taxes are growing fast to an unprecedented level then that design matters more than ever. A poorly designed system can disincentivise work, saving and investment, and hence undermine growth.
The UK tax system, in its current form, is very poorly designed and creates many damaging disincentives and distortions.
A good tax system: would be predictable, it would tax similar things similarly, it would avoid cliff edges, it would avoid unnecessary complexity, it would not tax transactions and it would not disincentivise savings or investment. Our current system fails on all those counts.
There are many studies that explain these failings. Indeed, there is considerable agreement about them. The failure of any recent government to have a coherent tax strategy has been damaging in its own right as households and businesses struggle with the uncertainty. In just the last couple of years both capital gains and pension lump sums have been taken early for fear of imminent policy changes.
There are multiple examples of terrible tax design. They include:
Income tax schedule. The income tax schedule has become bizarrely complex, with very high rates at some points, including a 60% rate between £100,000 and £125,140. Add on National Insurance and student loan repayments and that can reach 71% in total. Many more people are being affected as the £100,000 threshold has remained unchanged since 2010. What’s more withdrawal of childcare benefits means some people can actually be worse off earning £130,000 than earning £99,000.
Stamp duty land tax (SDLT). Stamp duty is a tax on moving, charged every time a home or commercial property changes hands. This is a disastrously damaging tax that actively keeps people and businesses stuck – restricting movement, growth and opportunity. Yet chancellors continually increase it, actively damaging the economy.
Capital gains tax. This is frequently changed and hence unpredictable. It treats different assets differently with no clear economic rationale. It is charged on nominal gains with no relief for inflation, only when an asset is sold and not at all on death. Investors thus have a strong reason to sit on assets rather than recycle capital into new businesses. The gap with income tax rates can also encourage people to reclassify earned income as capital gains.
This is not a question about the scale of the system or the degree of progressivity. We could design a tax system that raises as much revenue as the current system and does so just as progressively, but in a way which was much less damaging to incentives.
There is a remarkable degree of consensus about what a government that really prioritised growth should do to improve the tax system. The fact that no government has done so reflects in part a lack of will. It is also a reflection of the difficulty of making changes at a time when incomes are not growing. Low growth makes reform harder, which can lock in low growth.
This report shows the damaging ways in which individuals and businesses are impacted by the distortions in our tax system and how that leads to low growth. It looks at what trade-offs need to be made to design a system that encourages work, entrepreneurship and investment.
